Back to GetFilings.com
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to ___________
COMMISSION FILE NUMBER: 001-15933
BLUE VALLEY BAN CORP
(Exact name of registrant as specified in its charter)
KANSAS 48-1070996
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11935 RILEY 66225-6128
OVERLAND PARK, KANSAS
(Address of principal executive
offices) (Zip Code)
Registrant's telephone number, including area code: (913) 338-1000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
- ------------------- -----------------------------------------
Guarantee with respect to the Trust Preferred American Stock Exchange
Securities, $8.00 par value, of BVBC Capital Trust I
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by checkmark whether the registrant is an accelerated filer.
Yes [ ] No [X]
As of February 29, 2004 the registrant had 2,279,611 shares of Common
Stock ($1.00 par value) outstanding, of which 1,191,526 shares were held by
non-affiliates. The aggregate market value of the common shares of the
registrant held by non-affiliates, computed based on the June 30, 2003 closing
price of the stock, was approximately $33.4 million.
DOCUMENTS INCORPORATED BY REFERENCE
-----------------------------------
1. Part III - Proxy Statement for the 2004 Annual Meeting of
Stockholders
BLUE VALLEY BAN CORP
FORM 10-K INDEX
Page No.
PART I.
Item I. Business 2
Item 2. Properties 14
Item 3. Legal Proceedings 15
Item 4. Submission of Matters to a Vote of Security Holders 15
PART II.
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters 16
Item 6. Selected Financial Data 17
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations 19
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 36
Item 8. Financial Statements and Supplementary Data 38
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure 38
Item 9A. Controls and Procedures 39
PART III.
Item 10. Directors and Executive Officers of the Registrant 39
Item 11. Executive Compensation 39
Item 12. Security Ownership of Certain Beneficial Owners and Management 39
Item 13. Certain Relationships and Related Transactions 39
Item 14. Principal Accounting Fees and Services 40
PART IV.
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 41
1
PART I
ITEM 1: BUSINESS
THE COMPANY AND SUBSIDIARIES
Blue Valley Ban Corp. ("Blue Valley", the "Company") is a bank holding
company organized in 1989. In 2001, Blue Valley elected to become a financial
holding company and such status was granted. The Company's wholly-owned
subsidiary, Bank of Blue Valley (the "Bank") was also organized in 1989 to
provide banking services to closely-held businesses and their owners,
professionals and residents in Johnson County, Kansas, a high growth,
demographically attractive area within the Kansas City, Missouri - Kansas
Metropolitan Statistical Area (the "MSA"). The focus of Blue Valley has been to
take advantage of the current and anticipated growth in our market area as well
as to serve the needs of small and mid-sized commercial borrowers - customers
that we believe currently are underserved as a result of banking consolidation
in the industry generally and within our market specifically. In addition, Blue
Valley originates residential mortgages nationwide through the Bank's
InternetMortgage.com website.
We have experienced significant internal growth since our inception. We
currently have six banking center locations in Johnson County, Kansas, including
our main office and a mortgage operations office in Overland Park, both of which
include lobby banking centers, full-service offices in Olathe and Shawnee,
Kansas, and supermarket banking facilities in Leawood and Shawnee, Kansas. We
are nearing completion of a full service banking center located at 135th and
Mission Road in Leawood, Kansas. This location is scheduled to open during the
second quarter of 2004.
Our lending activities focus on commercial lending and residential
mortgage origination services, and to a lesser extent, consumer lending. We
strive to identify, develop and maintain diversified lines of business which
provide acceptable returns on a risk-adjusted basis. Our primary lines of
business consist of commercial and industrial lending, commercial real estate
lending, construction lending, indirect lending, leasing, and residential
mortgage lending and origination services.
We also seek to develop lines of business which diversify our revenue
sources, increase our non-interest income and offer additional value-added
services to our customers. We develop these new lines of business while
monitoring related risk factors. The growth experienced in 2003 and 2002 in our
residential mortgage origination services provides an example of the benefits
that we have gained through diversification. This growth has largely been
attained in a favorable low interest rate environment. Management recognizes
that future increases in interest rates could have a detrimental impact on the
revenues generated by this business and we seek to manage this business to
enable us to minimize this detrimental impact where possible. In addition to
fees generated in conjunction with our lending activities, we derive
non-interest income by providing mortgage origination services, deposit and cash
management services, investment brokerage services and trust services.
In addition to the Bank, we have four wholly-owned subsidiaries: Blue
Valley Building Corp., which owns the building and property that comprise our
headquarters and mortgage operations facility in Overland Park, Kansas, the
banking center at 135th and Mission Road in Leawood, Kansas, and one other
property intended for future use; Blue Valley Insurance Services, Inc., an
insurance agency created to offer insurance products to our customers; and BVBC
Capital Trust I and BVBC Capital Trust II, which were created to offer the
Company's trust preferred securities and to purchase our junior subordinated
debentures.
OUR MARKET AREA
We operate primarily as a community bank, serving the banking needs of
small and medium-sized companies and individuals in the Kansas City MSA
generally, and in suburban Johnson County, in particular. Our trade area
generally consists of Johnson County, Kansas. We believe that coupling our
strategy of providing exceptional customer service and local decision making
with attractive market demographics has led to a rate of growth which exceeds
the national total asset and deposit growth rates of the banking industry as
well as the growth experienced locally by many of our competitors.
2
The income levels and growth rate of Johnson County, Kansas compare
favorably to national averages. Johnson County's population growth rate ranks in
the top 2% of counties nationally, and its per capita income ranks in the top 1%
of counties nationally. Johnson County is also a significant banking market in
the State of Kansas and in the Kansas City MSA. According to available industry
data, as of June 30, 2003, total deposits in Johnson County, including those of
banks, thrifts and credit unions, were approximately $10.3 billion, which
represented 22.90% of total deposits in the state of Kansas and 35.61% of total
deposits in the Kansas City MSA.
As our founders anticipated, the trade area surrounding our main
banking facility in Overland Park has become one of the most highly developed
retail areas in the Kansas City MSA. Our Olathe, Kansas branch is located
approximately 10 miles west of our main office. We opened our Olathe branch in
1994 when we acquired the deposits of a branch of a failed savings and loan
association. We made this acquisition because it was located in a contiguous
market area and we believed that it represented a stable deposit base. The
Shawnee, Kansas banking facilities are approximately 20 miles northwest of our
headquarters location. We opened our Shawnee grocery branch for the convenience
of our existing customers in Shawnee, and to expand our market presence in
Shawnee. During the first quarter of 2001, construction of our freestanding
banking facility in Shawnee, Kansas was completed and operations commenced. The
Leawood, Kansas grocery branch is approximately 5 miles southeast of our
headquarters location. We opened our Leawood grocery branch during October of
2002 to provide us a physical presence and expand our market penetration in
Leawood. In 2002, we also acquired land for a 20,000 square foot branch and
office building in Leawood, which we anticipate will open in the second quarter
of 2004. During 2003 we acquired an office building approximately 1 mile
northwest of our headquarters location. At this location, we consolidated our
mortgage operations and opened a banking facility.
LENDING ACTIVITIES
Overview. Our principal loan categories include commercial, commercial
real estate, construction, leasing and residential mortgages. We also offer a
variety of consumer loans. Our primary source of interest income is interest
earned on our loan portfolio. As of December 31, 2003, our loans represented
approximately 67.77% of our total assets, our legal lending limit to any one
borrower was $14.2 million, and our largest single borrower as of that date had
outstanding loans of $12.8 million.
We have been successful in expanding our loan portfolio because of the
commitment of our staff and the economic growth in our area of operation. Our
staff has significant experience in lending and has been successful in offering
our products to both potential customers and existing customers. We believe that
we have been successful in maintaining our customers because of our staff's
attentiveness to their financial needs and the development of personal
relationships with them. We strive to become a strategic business partner with
our customers, not just a source of funds.
We conduct our lending activities pursuant to the loan policies adopted
by our board of directors. These policies currently require the approval of our
loan committee of all commercial credits in excess of $600,000 and all real
estate credits in excess of $1.0 million. Credits up to $600,000 on commercial
loans and $1.0 million on real estate loans can be approved by the Bank's
President. Our management information systems and loan review policies are
designed to monitor lending sufficiently to ensure adherence to our loan
policies. The following table shows the composition of our loan portfolio at
December 31, 2003.
3
LOAN PORTFOLIO
AS OF DECEMBER 31, 2003
-----------------------
AMOUNT PERCENT
(DOLLARS IN THOUSANDS)
Commercial $ 109,818 25.86%
Commercial real estate 87,438 20.59
Construction 123,445 29.08
Leases 22,175 5.22
Residential real estate 27,017 6.37
Consumer 29,701 6.99
Home equity 25,026 5.89
---------- ------
Total loans and leases 424,620 100.00%
Less allowance for loan losses 7,051
----------
Loans receivable, net $ 417,569
----------
Commercial loans. As of December 31, 2003, approximately $109.8
million, or 25.86%, of our loan portfolio represented commercial loans. The Bank
has developed a strong reputation in the servicing of small business and
commercial loans. We have expanded this portfolio through the addition of
commercial lending staff, their business development efforts and our reputation.
Commercial loans have historically been a significant portion of our loan
portfolio and we expect to continue our emphasis on this loan category.
The Bank's commercial lending activities historically have been
directed to small and medium-sized companies in or near Johnson County, Kansas,
with annual sales generally between $100,000 and $20 million. The Bank's
commercial customers are primarily firms engaged in manufacturing, service,
retail, construction, distribution and sales with significant operations in our
market areas. The Bank's commercial loans are primarily secured by real estate,
accounts receivable, inventory and equipment, and the Bank may seek to obtain
personal guarantees for its commercial loans. As of December 31, 2003,
approximately 10.59% of our commercial loans had outstanding balances in excess
of $300,000, and these loans accounted for 65.79% of the total carrying value of
our commercial loan portfolio. The Bank primarily underwrites its commercial
loans on the basis of the borrowers' cash flow and ability to service the debt,
as well as the value of any underlying collateral and the financial strength of
any guarantors.
Approximately $8.9 million, or 8.06%, of our commercial loans are Small
Business Administration (SBA) loans, of which $6.6 million is government
guaranteed. The SBA guarantees the repayment of a portion of the principal on
these loans, plus accrued interest on the guaranteed portion of the loan. Under
the federal Small Business Act, the SBA may guarantee up to 85% of qualified
loans of $150,000 or less and up to 75% of qualified loans in excess of
$150,000, up to a maximum guarantee of $1.0 million. We are an active SBA lender
in our market area and have been approved to participate in the SBA Certified
Lender Program.
Commercial lending is subject to risks specific to the business of each
borrower. In order to address these risks, we seek to understand the business of
each borrower, place appropriate value on any personal guarantee or collateral
pledged to secure the loan, and structure the loan amortization to maintain the
value of any collateral during the term of the loan.
Commercial real estate loans. The Bank also makes loans to provide
permanent financing for retail and office buildings, multi-family properties and
churches. As of December 31, 2003, approximately $87.4 million, or 20.59%, of
our loan portfolio represented commercial real estate loans. Our commercial real
estate loans are underwritten on the basis of the appraised value of the
property, the cash flow of the underlying property, and the financial strength
of any guarantors.
Risks inherent in commercial real estate lending are related to the
market value of the property taken as collateral, the underlying cash flows and
documentation. Commercial real estate lending involves more risk than
residential lending because loan balances may be greater and repayment is
dependent on the borrower's operations.
4
We attempt to mitigate these risks by carefully assessing property values,
investigating the source of cash flow servicing the loan on the property and
adhering to our lending and underwriting policies and procedures.
Construction loans. Our construction loans include loans to developers,
home building contractors and other companies and consumers for the construction
of single-family homes, land development, and commercial buildings, such as
retail and office buildings and multi-family properties. As of December 31,
2003, approximately $123.4 million, or 29.08%, of our loan portfolio represented
real estate construction loans. The builder and developer loan portfolio has
been a consistent and profitable component of our loan portfolio over our
fourteen-year history. We attribute this success to our expertise, availability
and prompt service. The Bank's experience and reputation in this area have
grown, thereby enabling it to focus on relationships with a smaller number of
larger builders and increasing the total value of the Bank's real estate
construction portfolio. Construction loans are made to qualified builders to
build houses to be sold following construction, pre-sold houses and model
houses. These loans are generally underwritten based upon several factors,
including the experience and current financial condition of the borrowing
entity, amount of the loan to appraised value, and general conditions of the
housing market. Construction loans are also made to individuals for whom houses
are being constructed by builders with whom the Bank has an existing
relationship. Such loans are made on the basis of the individual's financial
condition, the loan to value ratio, the reputation of the builder, and whether
the individual will be pre-qualified for permanent financing.
Risks related to construction lending include assessment of the market
for the finished product, reasonableness of the construction budget, ability of
the borrower to fund cost overruns, and the borrower's ability to liquidate and
repay the loan at a point when the loan-to-value ratio is the greatest. We seek
to manage these risks by, among other things, ensuring that the collateral value
of the property throughout the construction process does not fall below
acceptable levels, ensuring that funds disbursed are within parameters set by
the original construction budget, and properly documenting each construction
draw.
Lease financing. Our lease portfolio includes capital leases that we
have originated and leases that we have acquired from brokers or third parties.
As of December 31, 2003, our lease portfolio totaled $22.2 million or 5.22%, of
our total loan portfolio, consisting of $16.5 million principal amount of leases
originated by us and $5.7 million principal amount of leases that we purchased.
We provide lease financing for a variety of equipment and machinery, including
office equipment, heavy equipment, telephone systems, tractor trailers and
computers. Lease terms are generally from three to five years. Management
believes this area is attractive because of its ability to provide a source of
both interest and fee income. Our leases are generally underwritten based upon
several factors, including the overall credit worthiness, experience and current
financial condition of the lessee, the amount of the financing to collateral
value, and general conditions of the market.
The primary risks related to our lease portfolio are the value of the
underlying collateral and specific risks related to the business of each
borrower. To address these risks, we attempt to understand the business of each
borrower, value the underlying collateral appropriately and structure the loan
amortization to ensure that the value of the collateral exceeds the lease
balance during the term of the lease.
Residential real estate loans. Our residential real estate loan
portfolio consists primarily of first and second mortgage loans on residential
properties. As of December 31, 2003, $27.0 million, or 6.37%, of our loan
portfolio represented residential mortgage loans. The terms of these loans
typically include 2-5 year balloon payments based on a 15 to 30 year
amortization, and accrue interest at a fixed or variable rate. By offering these
products, we can offer credit to individuals who are self-employed or have
significant income from partnerships or investments. These individuals are often
unable to satisfy the underwriting criteria permitting the sale of their
mortgages into the secondary market. Due to interest rate risk considerations,
we generally sell our fixed rate residential mortgage loans in the secondary
market.
In addition, we also originate residential mortgage loans with the
intention of selling these loans in the secondary market. During 2003, we
originated approximately $1.5 billion of residential mortgage loans, and we sold
approximately $1.6 billion in the secondary market. We originate conventional
first mortgage loans through our internet website as well as through referrals
from real estate brokers, builders, developers, prior customers and media
advertising. We have offered customers the ability to apply for mortgage loans
and to pre-qualify for mortgage loans over the Internet since 1999. In 2001, we
expanded our internet mortgage application capacity with the acquisition of the
internet domain name InternetMortgage.com and created a separate National
Mortgage
5
division. The timing of this expansion allowed us to establish this division in
a relatively low-rate environment, and reap the benefits of a significant
increase in mortgage originations and refinancing experienced since 2001. The
origination of a mortgage loan from the date of initial application through
closing normally takes 15 to 60 days. We acquire forward commitments from
investors on mortgage loans that we intend to sell into the secondary market to
reduce market risk on mortgage loans in the process of origination and those
held for sale.
Our mortgage loan credit review process is consistent with the
standards set by traditional secondary market sources. We review appraised value
and debt service ratios, and we gather data during the underwriting process in
accordance with various laws and regulations governing real estate lending.
Loans originated by the Bank are sold with servicing released to increase
current income and reduce the costs associated with retaining servicing rights.
Commitments are obtained from the appropriate investor on a loan-by-loan basis
on a 30, 45 or 60-day delivery commitment. Interest rates are committed to the
borrower when a rate commitment is obtained from the investor. Loans are funded
by the Bank and purchased by the investor within 30 days following closing
pursuant to commitments obtained at the time of origination. We sell
conventional conforming loans and all loans that are non-conforming as to credit
quality to secondary market investors for cash on a non-recourse basis.
Consequently, foreclosure losses on all sold loans are generally the
responsibility of the investor and not that of the Bank.
As with other loans to individuals, the risks related to residential
mortgage loans include primarily the value of the underlying property and the
financial strength and employment stability of the borrower. We attempt to
manage these risks by performing a pre-funding underwriting that consists of the
verification of employment and utilizes a detailed checklist of loan
qualification requirements, including the source and amount of down payments,
bank accounts, existing debt and overall credit.
Consumer and other loans. As of December 31, 2003, our consumer and
other loans totaled $29.7 million, or 6.99%, of our total loan portfolio. A
substantial part of this amount consisted of installment loans to individuals in
our market area. Installment lending offered directly by the Bank in our market
area includes automobile loans, recreational vehicle loans, home improvement
loans, unsecured lines of credit and other loans to professionals, people
employed in education, industry and government, as well as retired individuals
and others. A significant portion of our consumer loan portfolio consists of
indirect automobile loans offered through automobile dealerships located
primarily in our trade area. As of December 31, 2003, approximately $20.0
million, or 4.71%, of our loan portfolio represented indirect installment loans.
Our loans made through this program generally represent loans to purchase new
automobiles. There are currently 22 dealerships participating in this program.
Since 1999, we have offered customers the ability to apply for consumer
loans, personal lines of credit and overdraft protection lines of credit over
the Internet through our electronic banking services. To date, consumer loan
applications received over the Internet have not represented a material amount
of our consumer loan portfolio. Our consumer and other loans are underwritten
based on the borrower's income, current debt, past credit history, collateral,
and the reputation of the originating dealership with respect to indirect
automobile loans.
Consumer loans are subject to the same risks as other loans to
individuals, including the financial strength and employment stability of the
borrower. In addition, some consumer loans are subject to the additional risk
that the loan is not secured by collateral. For some of the loans that are
secured, the underlying collateral may be rapidly depreciating and not provide
an adequate source of repayment if we are required to repossess the collateral.
We attempt to mitigate these risks by requiring a down payment and carefully
verifying and documenting the borrower's credit quality, employment stability,
monthly income, and with respect to indirect automobile loans, understanding and
documenting the value of the collateral and the reputation of the originating
dealership.
INVESTMENT ACTIVITIES
The objectives of our investment policy are to:
- secure the safety of principal;
- provide adequate liquidity;
6
- provide securities for use in pledging for public funds or
repurchase agreements; and
- maximize after-tax income.
We invest primarily in direct obligations of the United States,
obligations guaranteed as to principal and interest by the United States,
obligations of agencies of the United States and bank-qualified obligations of
state and local political subdivisions. In order to ensure the safety of
principal, we typically do not invest in mortgage-backed securities, corporate
debt, or other securities even though they are permitted by our investment
policy. In addition, we enter into federal funds transactions with our principal
correspondent banks, and depending on our liquidity position, act as a net
seller or purchaser of these funds. The sale of federal funds is effectively
short-term loans from us to other banks; while conversely, the purchase of
federal funds is effectively short-term loans from other banks to us.
DEPOSIT SERVICES
The principal sources of funds for the Bank are core deposits from the
local market areas surrounding the Bank's offices, including demand deposits,
interest-bearing transaction accounts, money market accounts, savings deposits
and time deposits of less than $100,000. Transaction accounts include
interest-bearing and non-interest-bearing accounts, which provide the Bank with
a source of fee income and cross-marketing opportunities as well as a low-cost
source of funds. Since 2001, the Bank has realized a significant level of
deposit growth from commercial checking accounts. While these accounts do not
earn interest, many of them receive an earnings credit on their average balance
to offset the cost of other services provided by the Bank. The Bank also offers
two types of short-term investment accounts. The Bank's money market account is
a daily access account that bears a higher rate than a personal interest-bearing
checking account and allows for limited check-writing ability. A significant
portion of our deposit growth during 2003 and 2002 has been attributable to our
Money Management Account, or "short-term parking account." The Money Management
Account provides a hybrid of the features available from a traditional money
market account and a traditional time deposit. The account requires a minimum
balance of $10,000 and allows for daily deposits but limits withdrawals to the
first day and the 15th day of each month. This account typically pays a tiered
rate of interest which is higher than a customer could receive on a traditional
money market account but lower than the rates generally available on time
deposits. We believe that the trade-off to depositors between higher interest
rates but more limited access to withdrawals has proven to be an attractive
product in our market areas and provides us with a more attractive source of
funds than other alternatives such as Federal Home Loan Bank borrowings, as it
provides us with the potential to cross-sell additional services to these
account holders. Time and savings accounts also provide a relatively stable and
low cost source of funding. The Bank's Funds Management policy also allows for
acceptance of brokered deposits which can be utilized to support the growth of
the Bank. As of December 31, 2003, the Bank had $35.8 million in brokered
deposits, and the Bank does not anticipate brokered deposits becoming a
significant percentage of its deposit base; however, we continue to evaluate
their potential role in the Bank's overall funding and liquidity strategies. In
pricing deposit rates, management considers profitability, the matching of term
lengths with assets, the attractiveness to customers and rates offered by our
competitors.
INVESTMENT BROKERAGE SERVICES
In 1999, the Bank began offering investment brokerage services through
an unrelated broker-dealer. These services are currently offered at our Overland
Park, Shawnee and Olathe locations. Two individuals responsible for providing
these services are joint employees of the Bank and the registered broker-dealer.
Investment brokerage services provide a source of fee income for the Bank. In
2003, the amount of our fee income generated from investment brokerage services
was $270,000.
TRUST SERVICES
We began offering trust services in 1996. Until 1999, the Bank's trust
services were offered exclusively through the employees of an unaffiliated trust
company. The Bank hired a full-time officer in 1999 to develop the Bank's trust
business. Trust services are marketed to both existing Bank customers and new
customers. We believe that the ability to offer trust services as a part of our
complement of financial services to new customers of the Bank
7
presents a significant cross-marketing opportunity. The services currently
offered by the Bank's trust department include the administration of
self-directed individual retirement accounts, qualified retirement plans,
custodial and directed trust accounts. As of December 31, 2003, the Bank's trust
department administered 195 accounts, with assets under management of
approximately $90.4 million. Trust services provide the Bank with a source of
fee income and additional deposits. In 2003, the amount of our fee income from
trust services was $217,000.
COMPETITION
We encounter competition primarily in seeking deposits and in obtaining
loan customers. The level of competition for deposits in our market area and
nationally is high. Our principal competitors for deposits are other financial
institutions within a few miles of our locations, including other banks, savings
institutions and credit unions. Competition among these institutions is based
primarily on interest rates offered, the quality of service provided, and the
convenience of banking facilities. Additional competition for depositors' funds
comes from U.S. government securities, private issuers of debt obligations and
other providers of investment alternatives for depositors.
We compete in our lending, investment brokerage and trust activities
with other financial institutions, such as banks and thrift institutions, credit
unions, automobile financing companies, mortgage companies, securities firms,
investment companies and other finance companies. Many of our competitors are
not subject to the same extensive federal regulations that govern bank holding
companies and federally insured banks and state regulations governing
state-chartered banks. As a result, these non-bank competitors have some
advantages over us in providing certain products and services. Many of the
financial institutions with which we compete are larger and possess greater
financial resources, name recognition and market presence.
EMPLOYEES
As of December 31, 2003, the Bank had approximately 261 full-time
employees. Blue Valley, Blue Valley Building Corp., BVBC Capital Trust I, BVBC
Capital Trust II and Blue Valley Investment Corp. did not have any employees.
Blue Valley Insurances Services, Inc. had 2 full-time employees as of December
31, 2003. None of the employees of the Company's subsidiaries are subject to a
collective bargaining agreement. We consider the Company's subsidiaries'
relationship with their employees to be excellent.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For each of our directors and our executive officers, we have set forth
below their ages as of December 31, 2003, and their principal positions.
8
Name Age Positions
- ---- --- ---------
Directors
Robert D. Regnier ................................. 55 President, Chief Executive Officer and Chairman of the
Board of Directors of Blue Valley; President, Chief
Executive Officer and Director of the Bank
Donald H. Alexander................................ 65 Director of Blue Valley and the Bank
Wayne A. Henry, Jr................................. 51 Director of Blue Valley
C. Ted McCarter.................................... 67 Director of Blue Valley and Chairman of the Board of
Directors of the Bank
Thomas A. McDonnell................................ 58 Director of Blue Valley
Additional Directors of the Bank
Harvey S. Bodker................................... 68 Director of the Bank
Suzanne E. Dotson.................................. 58 Director of the Bank
Charles H. Hunter.................................. 61 Director of the Bank
Executive Officers who are not Directors
Mark A. Fortino.................................... 37 Senior Vice President and Chief Financial Officer of
the Bank; Treasurer of Blue Valley
Ralph J. Schramp................................... 54 Senior Vice President - Commercial Lending and
Business Development for the Bank
Sheila Stokes...................................... 42 Senior Vice President - Retail Division of the Bank
REGULATION AND SUPERVISION
Blue Valley and its subsidiaries are extensively regulated under both
federal and state laws. Laws and regulations to which Blue Valley and the Bank
are subject govern, among other things, the scope of business, investments,
reserve levels, capital levels relative to operations, the nature and amount of
collateral for loans, the establishment of branches, mergers and consolidations
and the payment of dividends. These laws and regulations are intended primarily
to protect depositors, not stockholders. Any change in applicable laws or
regulations may have a material effect on Blue Valley's business and prospects,
and legislative and policy changes may affect Blue Valley's operations. Blue
Valley cannot predict the nature or the extent of the effects on its business
and earnings that fiscal or monetary policies, economic controls or new federal
or state legislation may have in the future.
The following references to statutes and regulations affecting Blue
Valley and the Bank are brief summaries only and do not purport to be complete
and are qualified in their entirety by reference to the statutes and
regulations.
APPLICABLE LEGISLATION
The enactment of legislation described below has significantly affected
the banking industry generally and will have an on-going effect on Blue Valley
and its subsidiaries.
GRAMM-LEACH-BLILEY ACT. The Gramm-Leach-Bliley Act was signed into law
on November 12, 1999. This major banking legislation expands the permissible
activities of bank holding companies such as Blue Valley by permitting them to
engage in activities, or affiliate with entities that engage in activities, that
are "financial in nature." Activities that the Act expressly deems to be
financial in nature include, among other things, securities and insurance
underwriting and agency, investment management and merchant banking. The Federal
Reserve and the Treasury Department, in cooperation with one another, determine
what additional activities are "financial in nature." With certain exceptions,
the Gramm-Leach-Bliley Act similarly expands the authorized activities of
subsidiaries of
9
national banks. The provisions of the Gramm-Leach-Bliley Act authorizing the
expanded powers became effective March 11, 2000.
Bank holding companies that intend to engage in activities that are
"financial in nature" must elect to become "financial holding companies."
Financial holding company status is only available to a bank holding company if
all of its affiliated depository institutions are "well capitalized" and "well
managed," based on applicable banking regulations, and have a Community
Reinvestment Act rating of at least "a satisfactory record of meeting community
credit needs." Financial holding companies and banks may continue to engage in
activities that are financial in nature only if they continue to satisfy the
well capitalized and well managed requirements. Bank holding companies that do
not elect to be financial holding companies or that do not qualify for financial
holding company status may engage only in non-banking activities deemed "closely
related to banking" prior to adoption of the Gramm-Leach-Bliley Act. In 2001,
Blue Valley elected to become a financial holding company.
The Act also calls for "functional regulation" of financial services
businesses in which functionally regulated subsidiaries of bank holding
companies will continue to be regulated by the regulator that ordinarily has
supervised their activities. As a result, state insurance regulators will
continue to oversee the activities of insurance companies and agencies, and the
Securities and Exchange Commission will continue to regulate the activities of
broker-dealers and investment advisers, even where the companies or agencies are
affiliated with a bank holding company. Federal Reserve authority to examine and
adopt rules regarding functionally regulated subsidiaries is limited.
The Gramm-Leach-Bliley Act imposed an "affirmative and continuing"
obligation on all financial service providers (not just banks and their
affiliates) to safeguard consumer privacy and requires federal and state
regulators, including the Federal Reserve and the FDIC, to establish standards
to implement this privacy obligation. With certain exceptions, the Act prohibits
banks from disclosing to non-affiliated parties any non-public personal
information about customers unless the bank has provided the customer with
certain information and the customer has had the opportunity to prohibit the
bank from sharing the information with non-affiliates. The new privacy
obligations became effective July 1, 2001.
The Gramm-Leach-Bliley Act has been and may continue to be the subject
of extensive rule making by federal banking regulators and others.
ECONOMIC GROWTH AND REGULATORY PAPERWORK REDUCTION ACT OF 1996. The
Economic Growth and Regulatory Paperwork Reduction Act of 1996 became law on
September 30, 1996. This Act streamlined the non-banking activities application
process for well-capitalized and well-managed bank holding companies by
permitting qualified bank holding companies to commence an approved non-banking
activity without prior notice to the Federal Reserve, although written notice is
required within 10 days after commencing the activity. Also, the Act reduced the
prior notice period to 12 days in the event of any non-banking acquisition or
share purchase, assuming the size of the acquisition does not exceed 10% of
risk-weighted assets of the acquiring bank holding company and the consideration
does not exceed 15% of a bank holding company's Tier 1 capital.
BANK HOLDING COMPANY REGULATION
Blue Valley is a registered bank holding company subject to periodic
examination by the Federal Reserve and required to file periodic reports of its
operations and such additional information as the Federal Reserve may require.
INVESTMENTS AND ACTIVITIES. A bank holding company must obtain approval
from the Federal Reserve before:
- Acquiring, directly or indirectly, ownership or control of any
voting shares of another bank or bank holding company if, after
the acquisition, it would own or control more than 5% of the
shares of the bank or bank holding company (unless it already owns
or controls the majority of the shares);
- Acquiring all or substantially all of the assets of another bank
or bank holding company; or
10
- Merging or consolidating with another bank holding company.
The Federal Reserve will not approve any acquisition, merger or
consolidation that would have a substantially anticompetitive result unless the
anticompetitive effects of the proposed transaction are clearly outweighed by a
greater public interest in meeting the convenience and needs of the community to
be served. The Federal Reserve also considers capital adequacy and other
financial and managerial factors in reviewing acquisitions or mergers.
With certain exceptions, a bank holding company is also prohibited
from:
- Acquiring or retaining direct or indirect ownership or control of
more than 5% of the voting shares of any company that is not a
bank or bank holding company; and
- Engaging, directly or indirectly, in any business other than that
of banking, managing and controlling banks or furnishing services
to banks and their subsidiaries.
Bank holding companies may, however, engage in businesses found by the
Federal Reserve to be "financial in nature," as describe above. As a financial
holding company, Blue Valley is authorized to engage in the expanded activities
permitted under the Gramm-Leach-Bliley Act as long as it continues to qualify
for financial holding company status.
Finally, subject to certain exceptions, the Bank Holding Company Act
and the Change in Bank Control Act, and the Federal Reserve's implementing
regulations, require Federal Reserve approval prior to any acquisition of
"control" of a bank holding company, such as Blue Valley. In general, a person
or company is presumed to have acquired control if it acquires 10% of the
outstanding shares of a bank or bank holding company and is conclusively
determined to have acquired control if it acquires 25% or more of the
outstanding shares of a bank or bank holding company.
SOURCE OF STRENGTH. The Federal Reserve expects Blue Valley to act as a
source of financial strength and support for the Bank and to take measures to
preserve and protect the Bank in situations where additional investments in the
Bank may not otherwise be warranted. The Federal Reserve may require a bank
holding company to terminate any activity or relinquish control of a non-bank
subsidiary (other than a non-bank subsidiary of a bank) upon the Federal
Reserve's determination that the activity or control constitutes a serious risk
to the financial soundness or stability of any subsidiary depository institution
of the bank holding company. Further, federal bank regulatory authorities have
additional discretion to require a bank holding company to divest itself of any
bank or non-bank subsidiary if the agency determines that divestiture may aid
the depository institution's financial condition. Blue Valley Building Corp.,
Blue Valley Insurance Services, Inc., BVBC Capital Trust I and BVBC Capital
Trust II are Blue Valley's only direct subsidiaries that are not banks.
CAPITAL REQUIREMENTS. The Federal Reserve uses capital adequacy
guidelines in its examination and regulation of bank holding companies and
banks. If the capital falls below minimum guideline levels, a bank holding
company, among other things, may be denied approval to acquire or establish
additional banks or non-bank businesses. The Federal Reserve's capital
guidelines establish a risk-based requirement expressed as a percentage of total
risk-weighted assets and a leverage requirement expressed as a percentage of
total assets. The risk-based requirement consists of a minimum ratio of total
capital to total risk-weighted assets of 8%, of which at least one-half must be
Tier 1 capital (which consists principally of stockholders' equity). The
leverage requirement consists of a minimum ratio of Tier 1 capital to total
assets of 3%.
The risk-based and leverage standards presently used by the Federal
Reserve are minimum requirements, and higher capital levels may be required if
warranted by the particular circumstances or risk profiles of individual banking
organizations. Further, any banking organization experiencing or anticipating
significant growth would be expected to maintain capital ratios, including
tangible capital positions, which is Tier 1 capital less all intangible assets,
well above the minimum levels.
DIVIDENDS. The Federal Reserve has issued a policy statement concerning
the payment of cash dividends by bank holding companies. The policy statement
provides that a bank holding company experiencing earnings
11
weaknesses should not pay cash dividends exceeding its net income or which could
only be funded in ways that weakened the bank holding company's financial
health, such as by borrowing. Also, the Federal Reserve possesses enforcement
powers over bank holding companies and their non-bank subsidiaries to prevent or
remedy actions that represent unsafe or unsound practices or violations of
applicable statutes and regulations. Among these powers is the ability to
proscribe the payment of dividends by banks and bank holding companies.
BANK REGULATIONS
The Bank operates under a Kansas state bank charter and is subject to
regulation by the Kansas Banking Department and the Federal Reserve Bank. The
Kansas Banking Department and the Federal Reserve Bank regulate or monitor all
areas of the Bank's operations, including capital requirements, issuance of
stock, declaration of dividends, interest rates, deposits, record keeping,
establishment of branches, acquisitions, mergers, loans, investments, borrowing,
security devices and procedures and employee responsibility and conduct. The
Kansas Banking Department places limitations on activities of the Bank including
the issuance of capital notes or debentures and the holding of real estate and
personal property and requires the Bank to maintain a certain ratio of reserves
against deposits. The Kansas Banking Department requires the Bank to file a
report annually showing receipts and disbursements of the Bank, in addition to
any periodic report requested.
DEPOSIT INSURANCE. The FDIC, through its Bank Insurance Fund, insures
the Bank's deposit accounts to a maximum of $100,000 for each insured depositor.
The FDIC, through its Savings Association Insurance Fund, insures certain
deposit accounts acquired by the Bank in 1994 from a branch of a failed savings
institution. These deposit accounts are insured to a maximum of $100,000 for
each insured depositor. The FDIC bases deposit insurance premiums on the
perceived risk each bank presents to its deposit insurance fund. In addition,
all Bank Insurance Fund-insured and Savings Association Insurance Fund-insured
institutions currently pay an assessment based on insured deposits to service
debt issued by the Financing Corporation, a federal agency established to
finance the recapitalization of the former Federal Savings and Loan Insurance
Corporation. The FDIC may terminate the deposit insurance of any insured
depository institution if the FDIC determines, after a hearing, that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations or has violated any
applicable law, regulation, order, or any condition imposed in writing by, or
written agreement with, the FDIC. The FDIC may also suspend deposit insurance
temporarily during the hearing process for a permanent termination of insurance
if the institution has no tangible capital. Management is not aware of any
activity or condition that could result in termination of the deposit insurance
of the Bank.
CAPITAL REQUIREMENTS. The FDIC has established the following minimum
capital standards for state-chartered, insured non-member banks, such as the
Bank: (1) a leverage requirement consisting of a minimum ratio of Tier 1 capital
to total assets of 3%; and (2) a risk-based capital requirement consisting of a
minimum ratio of total capital to total risk-weighted assets of 8%, at least
one-half of which must be Tier 1 capital. These capital requirements are minimum
requirements, and higher capital levels may be required if warranted by the
particular circumstances or risk profiles of individual institutions.
The federal banking regulators also have broad power to take "prompt
corrective action" to resolve the problems of undercapitalized institutions. The
extent of the regulators' powers depends upon whether the institution in
question is "well capitalized," "adequately capitalized," "undercapitalized,"
"significantly undercapitalized" or "critically undercapitalized." Under the
prompt corrective action rules, an institution is:
- "Well-capitalized" if the institution has a total risk-based
capital ratio of 10% or greater, a Tier 1 risk-based capital
ratio of 6% or greater, and a leverage ratio of 5% or greater,
and the institution is not subject to an order, written
agreement, capital directive, or prompt corrective action
directive to meet and maintain a specific capital level for
any capital measure;
- "Adequately capitalized" if the institution has a total
risk-based capital ratio of 8% or greater, a Tier 1 risk-based
capital ratio of 4% or greater, and a leverage ratio of 4% or
greater;
- "Undercapitalized" if the institution has a total risk-based
capital ratio that is less than 8%, a Tier 1 risk-based
capital ratio that is less than 4%, or a leverage ratio that
is less than 4%;
12
- "Significantly undercapitalized" if the institution has a
total risk-based capital ratio that is less than 6%, a Tier 1
risk-based capital ratio that is less than 3%, or a leverage
ratio that is less than 3%; and
- "Critically undercapitalized" if the institution has a ratio
of tangible equity to total assets that is equal to or less
than 2%.
The federal banking regulators must take prompt corrective action with
respect to capital deficient institutions. Depending upon the capital category
to which an institution is assigned, the regulators' corrective powers include:
- Placing limits on asset growth and restrictions on activities,
including the establishing of new branches;
- Requiring the institution to issue additional capital stock
(including additional voting stock) or to be acquired;
- Restricting transactions with affiliates;
- Restricting the interest rate the institution may pay on
deposits;
- Requiring that senior executive officers or directors be
dismissed;
- Requiring the institution to divest subsidiaries;
- Prohibiting the payment of principal or interest on
subordinated debt; and
- Appointing a receiver for the institution.
Companies controlling an undercapitalized institution are also required
to guarantee the subsidiary institution's compliance with the capital
restoration plan subject to an aggregate limitation of the lesser of 5% of the
institution's assets at the time it received notice that it was undercapitalized
or the amount of the capital deficiency when the institution first failed to
meet the plan. The Federal Deposit Insurance Act generally requires the
appointment of a conservator or receiver within 90 days after an institution
becomes critically undercapitalized.
As of December 31, 2003, the Bank had capital in excess of the
requirements for a "well-capitalized" institution.
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT. The Bank, having
over $500 million in total assets, is subject to numerous reporting requirements
of Section 112 of the Federal Deposit Insurance Corporation Act (FDICIA 112).
The primary purpose of FDICIA 112 is to provide a framework for early risk
identification in financial management through independent audits, more
stringent reporting requirements and an effective system of internal controls.
INSIDER TRANSACTIONS. The Bank is subject to restrictions on extensions
of credit to executive officers, directors, principal stockholders or any
related interest of these persons. Extensions of credit must be made on
substantially the same terms, including interest rates and collateral as the
terms available for third parties and must not involve more than the normal risk
of repayment or present other unfavorable features. The Bank is also subject to
lending limits and restrictions on overdrafts to these persons.
COMMUNITY REINVESTMENT ACT REQUIREMENTS. The Community Reinvestment Act
(CRA) of 1977 requires that, in connection with examinations of financial
institutions within their jurisdiction, the federal banking regulators must
evaluate the record of the financial institutions in meeting the credit needs of
their local communities, including low and moderate income neighborhoods,
consistent with the safe and sound operation of those banks. These factors are
also considered in evaluating mergers, acquisitions and applications to open a
branch or facility. In its most recent CRA examination dated June 10, 2002, the
Bank received a rating of "Satisfactory."
13
STATE BANK ACTIVITIES. With limited exceptions, FDIC-insured state
banks, like the Bank, may not make or retain equity investments of a rate or in
an amount that are not permissible for national banks and also may not engage as
a principal in any activity that is not permitted for a national bank or its
subsidiary, respectively, unless the bank meets, and continues to meet, its
minimum regulatory capital requirements and the FDIC determines that the
activity would not pose a significant risk to the deposit insurance fund of
which the bank is a member.
REGULATIONS GOVERNING EXTENSIONS OF CREDIT. The Bank is subject to
restrictions on extensions of credit to Blue Valley and on investments in Blue
Valley's securities and using those securities as collateral for loans. These
regulations and restrictions may limit Blue Valley's ability to obtain funds
from the Bank for its cash needs, including funds for acquisitions and for
payment of dividends, interest and operating expenses. Further, the Bank Holding
Company Act and Federal Reserve regulations prohibit a bank holding company and
its subsidiaries from engaging in various tie-in arrangements in connection with
extensions of credit, leases or sales of property or furnishing of services.
RESERVE REQUIREMENTS. The Federal Reserve requires all depository
institutions to maintain reserves against their transaction accounts. Reserves
of 3% must be maintained against net transaction accounts of $6.6 million to
$45.4 million plus 10% must be maintained against that portion of net
transaction accounts in excess $45.4 million (subject to adjustment by the
Federal Reserve). The balances maintained to meet the reserve requirements
imposed by the Federal Reserve may be used to satisfy liquidity requirements.
OTHER REGULATIONS
Interest and various other charges collected or contracted for by the
Bank are subject to state usury laws and other federal laws concerning interest
rates. The Bank's loan operations are also subject to federal laws applicable to
credit transactions. The federal Truth in Lending Act governs disclosures of
credit terms to consumer borrowers. The Home Mortgage Disclosure Act of 1975
requires financial institutions to provide information to enable the public and
public officials to determine whether a financial institution is fulfilling its
obligation to help meet the housing needs of the community it serves. The Equal
Credit Opportunity Act prohibits discrimination on the basis of race, creed or
other prohibited factors in extending credit. The Fair Credit Reporting Act of
1978 governs the use and provision of information to credit reporting agencies.
The Fair Debt Collection Act governs the manner in which consumer debts may be
collected by collection agencies. The various federal agencies charged with the
responsibility of implementing these federal laws have adopted various rules and
regulations. The deposit operations of the Bank are also subject to the Right to
Financial Privacy Act, which imposes a duty to maintain confidentiality of
consumer financial records and prescribes procedures for complying with
administrative subpoenas of financial records, and the Electronic Funds Transfer
Act, and Regulation E issued by the Federal Reserve to implement that Act, which
govern automatic deposits to and withdrawals from the use of ATMs and other
electronic banking services.
ITEM 2: PROPERTIES
The Company's principal office occupies 2.40 acres of ground on the
corner of 119th and Riley streets in Overland Park, Kansas. The construction of
the building was completed in 1994 and consists of 38,031 square feet. The
building and land are subject to third-party mortgage indebtedness in the
original principal amount of $2.5 million. As of December 31, 2003, the
outstanding principal amount of this indebtedness was $1.3 million.
In 2001, our Olathe, Kansas location was moved to a more suitable
property occupying 0.41 acres of ground on the corner of Santa Fe and Ridgeview
Streets. The building consists of 2,580 square feet on the main floor, plus
basement storage.
Our Shawnee, Kansas office currently occupies 425 square feet in a
grocery store located at Highway K-7 and 55th Street. The lease for this space
bears a primary term through December 2004. Our free-standing facility in
Shawnee, Kansas is also located at Highway K-7 and 55th Street and was completed
during the first quarter of 2001. The building consists of 4,000 square feet and
occupies 0.85 acres of land.
14
In January 2003, we purchased a 55,000 square foot building located on
the northwest corner of College Boulevard and Lowell in Overland Park, Kansas.
This building occupies 3.10 acres of ground and is leased to the Bank. The Bank
consolidated its mortgage operations and operates a small branch at this
facility.
Our current Leawood, Kansas banking center opened in 2002 and occupies
400 square feet in a grocery store located at 135th Street and Mission Road. The
lease for this space bears a primary term through June, 2005. Additionally, in
2001 we purchased undeveloped land on the corner of 135th Street and Mission
Road for the purposes of constructing a full-service banking center within a
two-story 20,000 square foot office building. We are nearing the completion of
the building and anticipate the banking center will open in the second quarter
of 2004.
In 1998, we purchased approximately 1.34 acres of undeveloped land on
the corners of K-68 and US 69 Highway in Louisburg, Kansas, just south of
Johnson County for potential future development as a full-service branch.
ITEM 3: LEGAL PROCEEDINGS
We are involved from time to time in routine litigation incidental to
our business. We are not a party to any pending litigation that is likely to
have a material adverse effect on our consolidated financial condition, results
of operations or cash flows.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our stockholders, through the
solicitation of proxies or otherwise, during the fourth quarter of the fiscal
year covered by this report.
15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET FOR COMMON STOCK
We are a reporting company under the Securities Exchange Act as a
result of a trust preferred securities offering we completed during July 2000.
Shares of our common stock have traded on the Over-The-Counter Bulletin Board
since July 2002 under the symbol "BVBC." As of February 29, 2004, there were
approximately 136 stockholders of record of our common stock. The following
table sets forth the high and low prices of the Company's common stock based on
close quotations provided by Yahoo.com. These prices reflect inter-dealer
prices, without retail mark-up, mark-down or commission and may not represent
actual transactions.
2003 2002
Fiscal Period High Low High Low
First Quarter $ 25.84 $ 20.53 $ n.a. $ n.a.
Second Quarter 27.83 22.42 n.a. n.a.
Third Quarter 29.82 26.34 26.66 16.82
Fourth Quarter 30.07 24.85 22.51 20.03
DIVIDENDS
During December 2003, our board of directors declared a cash dividend
on our common stock. A $0.15 per share dividend was paid on January 30, 2004, to
stockholders of record on December 31, 2003. During December 2002, our board of
directors declared a cash dividend of $0.10 per share of common stock and the
dividend was paid on January 15, 2003 to stockholders of record on December 31,
2002.
Because our consolidated net income consists largely of the net income
of the Bank, our ability to pay dividends on our common stock is subject to our
receipt of dividends from the Bank. The ability of the Bank to pay dividends to
us, and our ability to pay dividends to our stockholders, are regulated by
federal banking laws. In addition, if we elect to defer interest payments on our
outstanding junior subordinated debentures, we will be prohibited from paying
dividends on our common stock during such deferral.
Our board of directors intends to declare future dividends subject to
limitations imposed by regulatory capital guidelines in addition to
consideration of the Company's profitability and liquidity.
16
ITEM 6: SELECTED CONSOLIDATED FINANCIAL DATA
The following table presents our consolidated financial data as of and
for the five years ended December 31, 2003, and should be read in conjunction
with the consolidated financial statements and notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations," each
of which is included elsewhere in this Form 10-K. The selected statements of
condition and statements of income data, insofar as they relate to the five
years in the five-year period ended December 31, 2003, have been derived from
our audited consolidated financial statements.
AS OF AND FOR THE
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------ ------------ ------------ ------------ ------------
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
SELECTED STATEMENT OF INCOME DATA
Interest income:
Loans, including fees .............................. $ 28,293 $ 26,857 $ 27,921 $ 26,733 $ 20,422
Federal funds sold and interest-bearing deposits ... 49 297 679 777 431
Securities ......................................... 2,070 3,405 4,541 3,607 2,755
------------ ------------ ------------ ------------ ------------
Total interest income ........................... 30,412 30,559 33,141 31,117 23,608
------------ ------------ ------------ ------------ ------------
Interest expense:
Interest-bearing demand deposits ................... 165 388 815 872 644
Savings and money market deposit accounts .......... 2,204 2,711 4,846 5,726 3,156
Other time deposits ................................ 6,935 7,759 9,775 7,555 6,032
Funds borrowed ..................................... 4,245 3,368 2,958 2,543 1,372
------------ ------------ ------------ ------------ ------------
Total interest expense .......................... 13,549 14,226 18,394 16,696 11,204
------------ ------------ ------------ ------------ ------------
Net interest income ............................. 16,863 16,333 14,747 14,421 12,404
Provision for loan losses ............................. 1,350 2,920 2,400 1,950 2,144
------------ ------------ ------------ ------------ ------------
Net interest income after provision for loan
losses ........................................ 15,513 13,413 12,347 12,471 10,260
------------ ------------ ------------ ------------ ------------
Non-interest income:
Loans held for sale fee income ..................... 19,866 16,690 6,931 1,154 1,623
NSF charges & service fees ......................... 1,283 1,026 836 655 553
Other service charges .............................. 924 821 796 963 659
Realized gain on available-for-sale securities ..... - 193 500 - 3
Other income ....................................... 463 281 203 284 186
------------ ------------ ------------ ------------ ------------
Total non-interest income ....................... 22,536 19,011 9,266 3,056 3,024
Non-interest expense:
Salaries and employee benefits ..................... 19,670 16,437 10,063 5,856 4,578
Occupancy .......................................... 3,137 2,101 1,574 1,124 894
FDIC and other insurance ........................... 174 161 140 177 113
General & administrative ........................... 6,304 5,417 3,933 3,136 3,095
------------ ------------ ------------ ------------ ------------
Total non-interest expense ...................... 29,285 24,116 15,710 10,293 8,680
------------ ------------ ------------ ------------ ------------
Income before income taxes ......................... 8,764 8,308 5,903 5,234 4,604
Income tax provision ............................ 3,130 2,912 1,960 1,757 1,521
------------ ------------ ------------ ------------ ------------
Net income ...................................... $ 5,634 $ 5,396 $ 3,943 $ 3,477 $ 3,083
============ ============ ============ ============ ============
PER SHARE DATA
Basic earnings ..................................... $ 2.51 $ 2.48 $ 1.82 $ 1.62 $ 1.45
Diluted earnings ................................... 2.43 2.40 1.77 1.59 1.42
Dividends .......................................... 0.15 0.10 - - -
Book value basic (at end of period) ................ 17.64 15.47 13.11 11.12 8.83
Weighted average common shares outstanding:
Basic .......................................... 2,244,930 2,178,803 2,165,030 2,141,523 2,131,372
Diluted ........................................ 2,320,840 2,252,929 2,222,166 2,191,305 2,166,008
Dividend payout ratio .............................. 5.98% 4.04% -% -% -%
17
AS OF AND FOR THE
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
SELECTED FINANCIAL CONDITION DATA
(AT END OF PERIOD):
Total securities ...................................... $ 105,736 $ 61,364 $ 77,676 $ 78,503 $ 48,646
Total mortgage loans held for sale .................... 18,297 119,272 41,853 1,207 952
Total loans ........................................... 424,620 380,082 334,075 287,669 250,410
Total assets .......................................... 626,485 605,183 492,023 414,667 332,613
Total deposits ........................................ 470,495 423,787 394,245 338,221 268,145
Funds borrowed ........................................ 111,153 141,381 65,174 49,917 43,177
Total stockholders' equity ............................ 40,198 34,344 28,525 23,815 18,869
Trust assets under administration ..................... 90,389 44,245 41,571 35,268 19,436
SELECTED FINANCIAL RATIOS AND OTHER DATA:
Performance Ratios:
Net interest margin (1) ......................... 3.01% 3.35% 3.51% 4.35% 4.77%
Non-interest income to average assets ........... 3.62 3.55 2.02 0.84 1.06
Non-interest expense to average assets .......... 4.71 4.51 3.43 2.84 3.04
Net overhead ratio (2) .......................... 1.08 0.95 1.41 2.00 1.98
Efficiency ratio (3) ............................ 74.33 68.23 65.42 58.89 56.26
Return on average assets (4) .................... 0.91 1.01 0.86 0.96 1.08
Return on average equity (5) .................... 14.85 17.34 15.26 16.84 17.43
Asset Quality Ratios:
Non-performing loans to total loans ............. 0.72% 0.29% 0.92% 0.86% 0.21%
Allowance for possible loan losses to:
Total loans ................................... 1.66 1.82 1.58 1.54 1.52
Non-performing loans .......................... 230.79 618.29 171.96 179.47 710.80
Net charge-offs to average total loans .......... 0.30 0.36 0.51 0.49 0.32
Non-performing assets to total assets ........... 0.50 0.18 0.62 0.60 0.16
Balance Sheet Ratios:
Loans to deposits ............................... 90.25% 89.69% 84.74% 85.05% 93.39%
Average interest-earning assets to average
interest-bearing liabilities .................. 114.61 115.64 114.50 113.30 116.11
Capital Ratios:
Total equity to total assets .................... 6.42% 5.67% 5.80% 5.74% 5.67%
Total capital to risk-weighted assets ratio ..... 12.41 10.13 10.69 11.95 8.07
Tier 1 capital to risk-weighted assets ratio .... 10.04 8.82 8.87 9.51 6.82
Tier 1 capital to average assets ratio .......... 8.31 7.74 7.17 7.47 5.80
Average equity to average assets ratio .......... 6.10 5.82 5.64 5.70 6.20
- ---------------------
(1) Net interest income, on a full tax-equivalent basis, divided by average
interest-earning assets.
(2) Non-interest expense less non-interest income divided by average total
assets.
(3) Non-interest expense divided by the sum of net interest income plus
non-interest income.
(4) Net income divided by average total assets.
(5) Net income divided by average common equity.
18
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following presents management's discussion and analysis of our
financial condition and results of operations as of the dates and for the
periods indicated. You should read this discussion in conjunction with our
"Selected Consolidated Financial Data," our consolidated financial statements
and the accompanying notes, and the other financial data contained elsewhere in
this report.
This report contains forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended. The Company
intends such forward-looking statements to be covered by the safe harbor
provisions for forward-looking statements contained in the Private Securities
Litigation Reform Act of 1995, and is including this statement for purposes of
those safe harbor provisions. Forward-looking statements, which are based on
certain assumptions and describe future plans, strategies and expectations of
the Company, can generally be identified by use of the words "believe,"
"expect," "intend," "anticipate," "estimate," "project," or similar expressions.
The Company is unable to predict the actual results of its future plans or
strategies with certainty. Factors which could have a material adverse effect on
the operations and future prospects of the Company include, but are not limited
to, fluctuations in market rates of interest and loan and deposit pricing; a
deterioration of general economic conditions or the demand for housing in the
Company's market areas; a deterioration in the demand for mortgage financing;
legislative or regulatory changes; adverse developments in the Company's loan or
investment portfolio; any inability to obtain funding on favorable terms; the
loss of key personnel; significant increases in competition; and the possible
dilutive effect of potential acquisitions or expansions. These risks and
uncertainties should be considered in evaluating forward-looking statements and
undue reliance should not be placed on such statements.
CRITICAL ACCOUNTING POLICIES
Please refer to Note 1 of our consolidated financial statements where
we present a listing and discussion of our most significant accounting policies.
After a review of these policies, we determined that accounting for the
allowance for loan losses, income taxes, and stock-based compensation are deemed
critical accounting policies because of the valuation techniques used, and the
sensitivity of certain financial statement amounts to the methods, as well as
the assumptions and estimates, underlying these policies. Accounting for these
critical areas requires the most subjective and complex judgments that could be
subject to revision as new information becomes available.
As presented in Note 1 and Note 3 to the consolidated financial
statements, the allowance for loan losses represents management's estimate of
probable credit losses inherent in the loan portfolio as of the balance sheet
date. This evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes available. The
adequacy of the allowance is analyzed monthly based on internal loan reviews and
qualitative measurements of our loan portfolio. Management assesses the adequacy
of the allowance for loan losses based upon a number of factors including, among
others:
- analytical reviews of loan loss experience in relationship to
outstanding loans and commitments;
- unfunded loan commitments;
- problem and non-performing loans and other loans presenting
credit concerns;
- trends in loan growth, portfolio composition and quality;
- appraisals of the value of collateral; and
- management's judgment with respect to current economic
conditions and their impact on the existing loan portfolio.
The Bank computes its allowance by assigning specific reserves to
impaired loans, plus a general reserve based on loss factors applied to the rest
of the loan portfolio. The specific reserve on impaired loans is computed as the
amount of the loan in excess of the present value of the estimated future cash
flows discounted at the loan's effective interest rate, or based on the loan's
observable market value or the fair value of the collateral if the loan is
19
collateral dependent. The general reserve loss factors are determined based on
such items as management's evaluation of risk in the portfolio, local economic
conditions, and historical loss experience. To further assist in confirming the
results of the above-described allowance computation, during 1999, the Bank
refined its risk grading system by developing associated reserve factors for
each risk grade.
The income tax amounts in Note 7 to the consolidated financial
statements reflect the current period income tax expense for all periods
presented, as well as future tax liabilities and benefits associated with
differences in timing of expenses and income recognition for book and tax
accounting purposes. Our current tax liability and expense amounts are
determined using estimates and these estimates are subject to review and
possible revision by taxing authorities.
We discuss our accounting for stock-based compensation in greater
detail in Note 1 to our consolidated financial statements. Included in Note 1 is
the effect on our net income in the event we change our accounting of stock
options to the guidance presented by Statement of Financial Accounting Standards
No. 123 "Accounting for Stock-Based Compensation" from our current policy, which
follows Accounting Principles Board Opinion No. 25.
OVERVIEW
Net income for 2003 was $5.6 million, a $238,000, or 4.41% increase
over the $5.4 million earned in 2002. The principal contributors to our increase
in net income during 2003 were increases in net interest and non-interest
income. Diluted earnings per share increased 1.25% to $2.43 for the year ended
December 31, 2003 from $2.40 in the previous year. The Company's returns on
average assets and average stockholders' equity for 2003 were 0.91% and 14.85%,
compared to 1.01% and 17.34%, respectively, for 2002.
Net interest income for 2003 was $16.9 million compared to $16.3
million earned during 2002. The increase of $530,000 or 3.24% was primarily the
result of an increase in earning assets.
Non-interest income increased 18.54% to $22.5 million in 2003 from
$19.0 million in 2002. Non-interest income to average assets increased to 3.62%
in 2003 from 3.55% in 2002. The expansion of the Company's mortgage capabilities
coupled with continued declines in market interest rates resulted in a
significant increase in the number of residential mortgage loans originated and
sold in 2003 compared to 2002. This resulted in higher origination fees during
2003 than during 2002. However, increases in market rates, which occurred during
the second half of 2003, resulted in lower loans held for sale fee income.
Future market interest rate fluctuations and their resultant impact on loans
held for sale fee income are difficult to project or quantify; however, it is
likely that a future rise in interest rates would have a detrimental impact on
mortgage loan refinancing and lower loans held for sale fee income.
Total assets for the Company at December 31, 2003, were $626.5 million,
an increase of $21.3 million, or 3.51%, from $605.2 million at December 31,
2002. Deposits and stockholders' equity at December 31, 2003 were $470.5 million
and $40.2 million, compared with $423.8 million and $34.3 million at December
31, 2002, increases of $46.7 million, or 11.02%, and $5.9 million, or 17.04%,
respectively.
Loans at December 31, 2003 totaled $424.6 million, an increase of $44.5
million, or 11.71%, compared to December 31, 2002. The loan to deposit ratio at
December 31, 2003 was 90.25% compared to 89.69% at December 31, 2002. The
increase in the loan to deposit ratio was due to loan growth, which, on a
relative basis, slightly outpaced deposit growth. Our funding philosophy for
loans not held for sale has been to primarily increase deposits from retail and
commercial deposit sources and secondarily use other borrowing sources as
necessary to fund loans within the limits of the Bank's capital base.
Our low level of non-performing assets reflects the Bank's conservative
underwriting policies and aggressive management of impaired loans and has
resulted in low levels of nonaccrual loans. Over the five years ended December
31, 2003, our non-performing loans to total loans ratio has averaged 0.69%. As
of December 31, 2003, our ratio of non-performing loans to total loans was
0.72%, which was slightly above the historical average. Our non-performing
credit relationships are regularly reviewed and closely monitored. Our
philosophy has been to value non-performing loans at their estimated collectible
value and to aggressively manage these situations. Generally, the Bank maintains
its allowance for loan losses in excess of its non-performing loans. Over the
five years ended December 31, 2003, our ratio of allowance for loan losses to
non-performing loans has exceeded
20
170.00%. As of December 31, 2003, our ratio of allowance for loan losses to
non-performing loans was 230.79%, compared to 618.29% at December 31, 2002.
The net charge-off ratio has averaged 0.40% for the five years ended
December 31, 2003. Our net charge-off ratio for the year ended December 31, 2003
was 0.30%, which was significantly below our historical average. The Bank
continues to aggressively manage defaults in the loan portfolio in a softer
economic environment. Management intends to vigorously pursue collection of all
charged-off leases and loans.
NET INTEREST INCOME
A primary component of our net income is our net interest income. Net
interest income is determined by the spread between the fully tax equivalent
(FTE) yields we earn on our interest-earning assets and the rates we pay on our
interest-bearing liabilities, as well as the relative amounts of such assets and
liabilities. FTE net interest margin is determined by dividing FTE net interest
income by average interest-earning assets.
Years ended December 31, 2003 and 2002. FTE net interest income for
2003 increased to $17.2 million from $16.7 million in 2002, a $487,000, or
2.92%, increase.
FTE interest income for 2003 was $30.7 million, a decrease of $190,000,
or 0.62%, from $30.9 million in 2002, primarily as a result of continued asset
repricing in the current low interest rate environment. The yield on average
interest-earning assets fell to 5.38%, as compared to 6.21% in 2002, a decline
of 83 basis points. Average interest earning assets increased $73.3 million, or
14.73%, during 2003. Due to the increase in earning asset volume, loan interest
and fee income increased to $28.3 million in 2003 from $26.9 million in 2002, or
5.34%. Interest income on investment securities decreased by $1.4 million, or
36.77%, in 2003 compared to the prior year. The decline in market interest rates
caused many of the securities in our portfolio to be called. Generally, the
resultant return in principal was reinvested at lower yields; consequently, the
overall impact on the portfolio has been a decline in the yield in 2003 compared
to the prior year. The effect of the increase in earning assets was generally
offset by the decrease in yield.
Interest expense for 2003 was $13.5 million, down $677,000, or 4.76%,
from $14.2 million in 2002. The decrease results from a decline in the yields
paid on our interest bearing liabilities, primarily interest-bearing deposits.
Although total average interest bearing liabilities increased $67.9 million or
15.76% during 2003 mostly due to the increases in money market and time deposits
and FHLB borrowings, the yield on our total average interest bearing liabilities
and deposits decreased to 2.72% and 2.50%, respectively, in 2003 compared to
3.31% and 3.08% in 2002, respectively, decreases of 59 and 58 basis points,
respectively.
Years ended December 31, 2002 and 2001. FTE net interest income for
2002 increased to $16.7 million from $15.1 million in 2001, a $1.6 million, or
10.27%, increase.
FTE interest income for 2002 was $30.9 million, a decrease of $2.6
million, or 7.80%, from $33.5 million in 2001, primarily as a result of
continued decreases in market interest rates during 2002. The yield on average
interest-earning assets fell to 6.21%, as compared to 7.79% in 2001, a decline
of 158 basis points. Average interest earning assets increased $67.4 million or
15.67% during 2002. Due to the decrease in yields, loan interest and fee income
decreased slightly to $26.9 million in 2002 from $27.9 million in 2001, or
3.81%. Interest income on investment securities decreased by $1.2 million, or
23.77% in 2002 compared to the prior year. The decline in market interest rates
caused many of the securities in our portfolio to be called. Some of the
resultant return in principal has been reinvested; however, the overall impact
on the portfolio has been a decline in the balance and yield in 2002 compared to
the prior year.
Interest expense for 2002 was $14.2 million, down $4.2 million, or
22.66%, from $18.4 million in 2001. The decrease results from a decline in the
yields paid on our interest bearing liabilities, primarily interest-bearing
deposits. The yield on our total average interest bearing liabilities and
deposits decreased to 3.31% and 3.08%, respectively, in 2002 compared to 4.89%
and 4.81% in 2001, respectively, decreases of 158 and 173 basis points,
respectively. Total interest bearing liabilities increased $54.6 million or
14.52% during 2002. This increase was attributable mainly to the increases in
savings, money market and time deposits and FHLB borrowings.
21
Average Balance Sheets. The following table sets forth for the periods
and as of the dates indicated, information regarding our average balances of
assets and liabilities as well as the dollar amounts of interest income from
interest-earning assets and interest expense on interest-bearing liabilities and
the resultant yields or costs. Ratio, yield and rate information are based on
average daily balances where available; otherwise, average monthly balances have
been used. Nonaccrual loans are included in the calculation of average balances
for loans for the periods indicated.
AVERAGE BALANCES, YIELDS AND RATES
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
2003 2002
-------------------------------- ---------------------------------
AVERAGE AVERAGE
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE
---------- ---------- ------- ---------- ---------- -------
(DOLLARS IN THOUSANDS)
ASSETS
Federal funds sold .................................. $ 5,500 $ 49 0.89% $ 18,171 $ 297 1.63%
Investment securities - taxable ..................... 55,259 1,489 2.69 51,273 2,741 5.34
Investment securities - non-taxable (1) ............. 12,885 881 6.84 14,526 1,007 6.93
Mortgage loans held for sale ........................ 86,808 4,460 5.14 63,866 3,937 6.17
Loans, net of unearned discount and fees ............ 410,593 23,833 5.80 349,879 22,920 6.55
---------- ---------- ---------- ----------
Total earning assets .......................... 571,045 30,712 5.38 497,715 30,902 6.21
---------- ---------- ---------- ----------
Cash and due from banks - non-interest bearing ...... 30,453 22,910
Allowance for possible loan losses .................. (7,592) (5,547)
Premises and equipment, net ......................... 16,388 9,380
Other assets ........................................ 12,129 10,546
---------- ----------
Total assets .................................. $ 622,423 $ 535,004
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits-interest bearing:
Interest-bearing demand accounts ................ $ 26,415 $ 165 0.63% $ 29,779 $ 388 1.30%
Savings and money market deposits ............... 150,503 2,204 1.46 146,132 2,711 1.86
Time deposits ................................... 195,599 6,935 3.55 176,762 7,759 4.39
---------- ---------- ---------- ----------
Total interest-bearing deposits ............... 372,517 9,304 2.50 352,673 10,858 3.08
---------- ---------- ---------- ----------
Short-term borrowings ............................... 44,230 451 1.02 21,722 266 1.22
Long-term debt ...................................... 81,499 3,794 4.66 55,993 3,102 5.54
---------- ---------- ---------- ----------
Total interest-bearing liabilities ............ 498,246 13,549 2.72 430,388 14,226 3.31
---------- ---------- ---------- ----------
Non-interest bearing deposits ....................... 81,269 69,550 53,324
Other liabilities .................................. 4,959 3,952
Stockholders' equity .............................. 37,949 31,114
---------- ----------
Total liabilities and stockholders' equity .... $ 622,423 $ 535,004
========== ==========
Net interest income/spread ........................ $ 17,163 2.66% $ 16,676 2.90%
========== ==== ========== ====
Net interest margin................................ 3.01% 3.35%
==== ====
YEAR ENDED DECEMBER 31,
------------------------------------------
2001
------------------------------------------
AVERAGE
AVERAGE YIELD/
BALANCE INTEREST RATE
------------ ------------ -------
(DOLLARS IN THOUSANDS)
ASSETS
Federal funds sold .................................. $ 15,269 $ 679 4.45%
Investment securities - taxable ..................... 59,010 3,811 6.46
Investment securities - non-taxable (1) ............. 15,782 1,105 7.00
Mortgage loans held for sale ........................ 29,505 1,752 5.94
Loans, net of unearned discount and fees ............ 310,727 26,169 8.42
------------ ------------
Total earning assets .......................... 430,293 33,516 7.79
------------ ------------
Cash and due from banks - non-interest bearing ...... 16,224
Allowance for possible loan losses .................. (4,809)
Premises and equipment, net ......................... 7,435
Other assets ........................................ 9,133
------------
Total assets .................................. $ 458,276
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits-interest bearing:
Interest-bearing demand accounts ................ $ 31,441 $ 815 2.59%
Savings and money market deposits ............... 131,492 4,846 3.69
Time deposits ................................... 158,078 9,775 6.18
------------ ------------
Total interest-bearing deposits ............... 321,011 15,436 4.81
------------ ------------
Short-term borrowings ............................... 21,862 667 3.05
Long-term debt ...................................... 32,937 2,291 6.96
------------ ------------
Total interest-bearing liabilities ............ 375,810 18,394 4.89
------------ ------------
Non-interest bearing deposits ....................... 53,324
Other liabilities .................................. 3,295
Stockholders' equity .............................. 25,847
------------
Total liabilities and stockholders' equity .... $ 458,276
============
Net interest income/spread ........................ $ 15,122 2.88%
============ ====
Net interest margin................................ 3.51%
====
(1) Presented on a fully tax-equivalent basis assuming a tax rate of 34%. For
the three years ended December 31, 2003, 2002 and 2001, the tax equivalency
adjustment amounted to $300,000, $343,000, and 186,000, respectively
22
Analysis of Changes in Net Interest Income Due to Changes in Interest
Rates and Volumes. The following table presents the dollar amount of changes in
interest income and interest expense for major components of interest-earning
assets and interest-bearing liabilities. It distinguishes between the increase
or decrease related to changes in balances and changes in interest rates. For
each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to:
- changes in volume, reflecting changes in volume multiplied by
the current period rate; and
- changes in rate, reflecting changes in rate multiplied by the
prior period volume.
CHANGES IN INTEREST INCOME AND EXPENSE VOLUME AND RATE
VARIANCES
YEAR ENDED DECEMBER 31,
2003 COMPARED TO 2002 2002 COMPARED TO 2001
CHANGE CHANGE CHANGE CHANGE
DUE TO DUE TO TOTAL DUE TO DUE TO TOTAL
RATE VOLUME CHANGE RATE VOLUME CHANGE
------------ ------------ ------------ ------------ ------------ ------------
Federal funds sold $ (135) $ (113) $ (248) $ (429) $ 47 $ (382)
Investment securities -
taxable (1,359) 107 (1,252) (657) (414) (1,071)
Investment securities -
non-taxable (1) (14) (112) (126) (11) (87) (98)
Mortgage loans held for
sale (656) 1,179 523 67 2,118 2,185
Loans, net of unearned
discount (2,611) 3,524 913 (5,813) 2,565 (3,248)
------------ ------------ ------------ ------------ ------------ ------------
Total interest income (4,775) 4,585 (190) (6,843) 4,229 (2,614)
------------ ------------ ------------ ------------ ------------ ------------
Interest-bearing demand
accounts (202) (21) (223) (405) (22) (427)
Savings and money market
deposits (571) 64 (507) (2,407) 272 (2,135)
Time deposits (1,492) 668 (824) (2,836) 820 (2,016)
Short-term borrowings (45) 230 185 (399) (2) (401)
Long-term debt (495) 1,187 692 (466) 1,277 811
------------ ------------ ------------ ------------ ------------ ------------
Total interest expense (2,805) 2,128 (677) (6,513) 2,345 (4,168)
------------ ------------ ------------ ------------ ------------ ------------
Net interest income $ (1,970) $ 2,457 $ 487 $ (330) $ 1,884 $ 1,554
============ ============ ============ ============ ============ ============
(1) Presented on a fully tax-equivalent basis assuming a tax rate of 34%.
PROVISION FOR LOAN LOSSES
We make provisions for loan losses in amounts management deems
necessary to maintain the allowance for loan losses at an appropriate level.
During the year ended December 31, 2003, we provided $1.4 million for loan
losses, as compared to $2.9 million for the year ended December 31, 2002, a
decrease of $1.6 million, or 53.77%. During 2003, our provision for loan losses
decreased due to an overall improvement in credit quality, as indicated by the
decline in total impaired loans to $10.2 million at December 31, 2003 from $11.7
million at December 31, 2002. The provision for 2002 had been increased due to
risks associated with one commercial credit. The loan portfolio increased to
$424.6 million in 2003 from $380.1 million in 2002, or 11.71%. The provision for
loan losses increased to $2.9 million in 2002 from $2.4 million in 2001, or
21.67%, while the loan portfolio increased to $380.1 million in 2002 from $334.1
million in 2001, or 13.77%.
The allowance for loan losses as a percentage of loans was 1.66% at
December 31, 2003, as compared to 1.82% in 2002 and 1.58% in 2001. The decrease
in this percentage from December 31, 2002 was primarily due to the increased
provision for 2002 discussed in the previous paragraph. Therefore, with the
exception of the increase in the 2002 allowance, the December 31, 2003
percentage is consistent with previous years as displayed in the
23
Summary of Loan Loss Experience and Related Information table on page 29. We
increased the allowance for loan losses in 2003, 2002 and 2001 based upon an
analysis of several factors, including the impairment and general reserve factor
analysis referred to in our Critical Accounting Policies and changes in the loan
mix. Total impaired loans decreased to $10.2 million with a related reserve of
$1.5 million at December 31, 2003 compared to $11.7 million and $1.8 million,
respectively, at December 31, 2002. General reserve factors, which are applied
to categories of unimpaired loans, resulted in a decrease in the overall general
reserve percentage to 1.34% at December 31, 2003 compared to 1.38% at December
31, 2002. The overall general reserve percentage at December 31, 2001 was 1.17%.
The decrease in the general reserve factor in 2003 is attributable to changes in
the loan portfolio mix, with larger relative amounts of loans in loan categories
bearing lower general reserve factors.
Due to the factors discussed above and the growth in our commercial
real estate and construction loan portfolios, the overall result was a higher
allowance for loan losses at December 31, 2003 compared with December 31, 2002.
The allowance for loan losses represents our best estimate of probable losses
that have been incurred as of the respective balance sheet dates.
NON-INTEREST INCOME
The following table describes the items of our non-interest income for
the periods indicated:
NON-INTEREST INCOME
YEAR ENDED DECEMBER 31
--------------------------------
2003 2002 2001
---------- ---------- ----------
(IN THOUSANDS)
Loans held for sale fee income ........................ $ 19,866 $ 16,690 $ 6,931
NSF charges and service fees .......................... 1,283 1,026 836
Other service charges ................................. 924 821 796
Net realized gains on sales of investment securities .. - 193 500
Other income .......................................... 463 281 203
---------- ---------- ----------
Total non-interest income ....................... $ 22,536 $ 19,011 $ 9,266
========== ========== ==========
Non-interest income increased to $22.5 million, or 18.54%, during 2003,
from $19.0 million during 2002. This increase is attributable to increases in
loans held for sale fee income of $3.2 million and NSF charges and services fees
of $257,000. We experienced growth in our loans held for sale income due to the
expansion of our national and local mortgage capabilities concurrent with
favorable conditions for residential mortgage origination and refinancing.
Mortgage originations and refinancing continued to flourish due to the low
interest rate environment which began in 2001 and persisted through 2003. The
volume of closed residential mortgages grew to over $1.5 billion in 2003 from
$1.3 billion and $640 million in 2002 and 2001, respectively. However, mortgage
rates increased modestly during the second half of 2003, and the volume of
mortgage refinancing activity declined dramatically. Other service charge
income, which includes trust services income, investment brokerage income,
merchant bankcard processing and debit card processing income, increased by
$103,000 or 12.54% from 2002 to 2003. In 2002, we took advantage of
opportunities to mitigate the risk of long-term rate volatility in our
available-for-sale investment portfolio by selling some of our longer-term
bonds. Due to the yield environment when we sold the securities, we realized
$193,000 of net gains on the sales in 2002. Sustainability of the level of our
loans held for sale fee income is primarily dependent upon the persistence of
the low interest rate environment, and secondarily dependent on our ability to
develop new products and alternative delivery channels. Future growth of other
non-interest income categories is dependent upon new product development, and
growth in our customer base.
Non-interest income increased to $19.0 million, or 105.17%, during
2002, from $9.3 million during 2001. This increase is attributable to increases
in loans held for sale fee income of $9.8 million and NSF charges and services
fees of $190,000. We experienced significant growth in our loans held for sale
income due to the expansion of our national and local mortgage capabilities
concurrent with favorable conditions for residential mortgage origination and
refinancing. Mortgage originations and refinancing continued to flourish due to
the low interest rate environment which began in 2001 and persisted through
2002. Other service charge income, which includes trust
24
services income, investment brokerage income, merchant bankcard processing and
debit card processing income, remained relatively unchanged from 2001. In 2002
and 2001, we took advantage of opportunities to mitigate the risk of long-term
rate volatility in our available-for-sale investment portfolio by selling some
of our longer-term bonds. Due to the yield environment when we sold the
securities, we realized $193,000 and $500,000 of net gains on the sales in 2002
and 2001, respectively.
NON-INTEREST EXPENSE
The following table describes the items of our non-interest expense for
the periods indicated.
NON-INTEREST EXPENSE
YEAR ENDED DECEMBER 31
------------------------------------
2003 2002 2001
---------- ---------- ----------
(IN THOUSANDS)
Salaries and employee benefits .... $ 19,670 $ 16,437 $ 10,063
Occupancy ......................... 3,137 2,101 1,574
FDIC and other insurance expense .. 174 161 140
General and administrative ........ 6,304 5,417 3,933
---------- ---------- ----------
Total non-interest expenses .. $ 29,285 $ 24,116 $ 15,710
========== ========== ==========
Non-interest expense increased to $29.3 million, or 21.43%, during
2003, as compared to $24.1 million in the prior year. This increase is primarily
attributable to increases in salaries and employee benefits and occupancy
expenses, consistent with the Company's growth. Our salaries and employee
benefits expense increased to $19.7 million in 2003, or 19.66%, from $16.4
million in 2002, mainly due to volume-related growth in incentive compensation
related to mortgage origination activity as well as additional staff to
facilitate our growth. We manage our staffing levels to accommodate the volume
of our business. During 2003, FTEs fluctuated from approximately 257 to 313, and
ended the year at approximately 263. The fluctuations in our staffing levels
were primarily attributable to fluctuations in the volume of mortgage
originations during the year. Occupancy expenses increased to $3.1 million, or
49.30% in 2003, from $2.1 million in 2002, primarily due to the addition of our
7900 College facility and higher telecommunication and depreciation expenses
related to our growth and expansion. General and administrative expenses
increased $887,000 to $6.3 million in 2003, compared to $5.4 million in 2002,
principally due to increased marketing, postage/courier, and loan processing
fees associated with the increased volume in the Company's mortgage origination
departments. Future increases in non-interest expense are dependent upon
continued growth of the Company, especially our mortgage origination business.
Non-interest expense increased to $24.1 million, or 53.51%, during
2002, as compared to $15.7 million in the prior year. This increase was
primarily attributable to increases in salaries and employee benefits and
occupancy expenses, consistent with the Company's growth. Our salaries and
employee benefits expense increased to $16.4 million in 2002, or 63.34%, from
$10.1 million in 2001, as we hired additional staff to facilitate our growth. We
had 262 full-time equivalent employees at December 31, 2002 compared to 217 at
December 31, 2001. Many areas of the Company added employees to manage growth.
Occupancy expenses increased to $2.1 million, or 33.48% in 2002, from $1.6
million in 2001, primarily due to increases in depreciation, rent, telephone
expenses, and repairs and maintenance as the Company expanded its infrastructure
to facilitate growth. General and administrative expenses increased $1.5 million
to $5.4 million in 2002, compared to $3.9 million in 2001, principally due to
increased marketing, postage/courier, and loan processing fees associated with
the increased volume in the Company's mortgage origination departments.
INCOME TAXES
Our income tax expense during 2003 was $3.1 million, compared to $2.9
million during 2002, and $2.0 million during 2001. These increases reflect our
higher earnings for the current and previous fiscal years. Our
25
consolidated effective income tax rates of 35.71%, 35.05% and 33.20% for the
three respective years ended December 31, 2003 varies from the statutory rate
principally due to the effects of state income taxes and interest income earned
on our municipal securities portfolio which is generally tax-exempt for federal
income tax purposes.
FINANCIAL CONDITION
Lending Activities. Our